Would You Like Your Bailout As A One-Time Payment, Or Monthly Payments?

Sep. 14, 2012 10:06 AM ET

The first two rounds of Quantitative Easing that happened in 2009 (1)(2) were announced as one time payments. In both cases, markets rallied and expectations of an economic recovery were forthcoming. This is the case both in the US, and the Eurozone, where bailouts for Portugal and Greece were largely one time affairs. (3)(4)

There are rumblings now in the Eurozone about "Outright Monetary Transactions" (5)(6) which would effectively take these one-time events of issuing bonds and perform them on an as needed basis. Presumably, the need will be determined by a spike in bond yields, or a lack of demand for bonds in the US or the EU. Does this make any difference over a single announcement?

The differences that may become apparent are that the one-time events are now being distributed on a consistent basis. The volatility and anticipation which occurs before every meeting and every announcement will now disappear, and it will be replaced with ongoing support for the bonds. This may take people's attention away from QE in general, and the issuing of debt - money printing. Similar to the automated payment that gets forgotten, the concept of issuing debt will only arise when a crisis occurs where issuing debt is not possible, or the consequences cannot be ignored any longer. Also like that monthly automated payment, there tends to be a higher cost, because there is more work in issuing bonds each month than in one shot. This will also take pressure off the Fed and the ECB because they will be working consistently, and will not have to constantly have more bailouts approved.

What is the problem with this? The issuing of more money may in fact lead to inflation or deflation (depending on which camp you are in) and when the crisis comes again, it may be much too late to do anything about it. If in fact, bond yields should be skyrocketing and they are not, this is controlling the free market, which will cause distortions on the riskiness of debt, and the currency attached to that debt. What this means is if a US bond yields 1% because the Fed keeps buying it, but the risk really warrants a yield of 5% when the Fed does not buy it, and the fed suddenly stops buying the bonds, there can be a shock of great magnitude which would wipe out untold amounts of wealth. This is still possible today if the Fed did not buy any bonds, but since people are watching the Fed actions through the meetings, at least there is some awareness and some anticipation if QE gets limited.

Bailouts tend to be high impact announcements. The effect of this continuous bond purchasing is to change how the impact is perceived.